Expect Short-Term Volatility; Be Selective and Patient

We believed that the market was due some consolidation, as the S&P 500 reached 14% above its 200 DMA and the slope of the ascent had gotten pretty steep. However, the 9.7% pullback in a little over a week (peak to trough) took the S&P 500 from overbought to oversold in a hurry. Support levels offer little “support” in waterfall selloff moments. The 20, 30, 50 day moving averages, as well as our favored area of support (2700), were all undercut.

Interestingly, 2600 (the market breakout following the tax bill emerging from the Senate Budget Committee) acted as support. The volatile fluctuations experienced this week following the sharp pullback are normal as the market consolidates its recent moves and builds a base for renewed upside. We expect this volatile sideways action to continue over the short term. 2600 (November 28 breakout and Monday’s intraday low) and 2580 (uptrend) are the next key levels of support. We doubt the market moves meaningfully below the 200 DMA (2538) given the supportive economic and fundamental backdrop.

What spooked investors was wage growth moving higher in the January jobs report (last Friday) to 2.9% (up from an upwardly revised 2.7% in December). While wages and inflation remain very low, the path of both will continue to be closely monitored by investors due to the impact they can have on interest rates and monetary policy. The concern is that an inflationary problem in the future could result in the Fed being tighter than expected, which can result in an inverted yield curve and affect economic conditions in a negative way. The movement of these (along with potential protectionist trade policies) will be key variables to monitor, as they rear their head up over the course of this year.

The economic and fundamental backdrop remains supportive of equities. Global PMI broke to the upside this month, continuing the synchronized upswing in global economic activity. Earnings continue to come in stronger than expected, and expectations for 2018 growth are up to 18.4% (from 11% on December 31). Valuation is also now less of a headwind with a NTM P/E of 16.8x (vs a 5 year average of 16.04x).

We expect the short term will likely be volatile, as consolidation of the sharp move occurs. The intermediate term remains supportive, in our view, with strong earnings and economic growth (watch inflationary pressures). Stock selectivity and patience will be more important this year. As the market fluctuates, we expect there will be opportunities to buy quality companies with strong fundamentals near longer-term support levels.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. and are subject to change. Past performance is not an indication of future results and there is no assurance that any of the forecasts mentioned will occur. The S&P 500 is an unmanaged index of 500 widely held stocks. An investment cannot be made in this index. The performance noted does not include fees or charges, which would reduce an investor's returns. Legislative and regulatory agendas are subject to change at the discretion of leadership or as dictated by events. The 200-day moving average is a popular technical indicator which investors use to analyze price trends. It is simply a security's average closing price over the last 200 days. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

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